What if it is the other way round!

The chicken and egg problem of economic development and corruption.

Mohamed Bouazizi was a fruit vendor in Tunisia. On 17 December 2010, he set himself on fire in protest against unjust behaviour and corruption. What followed toppled at least four entrenched dictatorships—Egypt, Libya, Yemen and, of course, Tunisia—and triggered massive protests in more than 18 countries against autocracy and human rights violations. Year 2011 was marked by massive movements against corruption across the globe. India too saw its share of protests in 2011 with Anna Hazare’s fast and subsequent arrest becoming the rallying point of this movement.

By and large developed countries are perceived to have lower levels of corruption than developing countries, though the developed world has seen its share of scandals and shaming—the IRS scandal in the US, the Lagarde List in Greece, the phone-hacking controversy in the UK, and the series of corruption allegations that led to Italy’s setting up the National Anti-Corruption Authority.[ii]  Chart 1 below reproduced from Transparency International provides intuitive evidence of the possible link between economic development and level of corruption. The correlation between the Corruption Perception Index (Transparency International) and per capita GDP (IMF) in 2012 turns out to be 0.77.

Chart 1: The developed world appears to have lower levels of corruption

Source: Transparency International, http://cpi.transparency.org/cpi2012/results/

Such a high level of correlation between economic development and corruption across countries has naturally led to the growing consensus that corruption negatively impacts growth and development. The biggest challenge for growth in an environment of corruption comes from the lack of predictability in policy and outcomes, which is essential for investment and growth. To some extent, India is witnessing this, specifically with respect to the Telecom and Coal sectors. In the long-term, corruption distorts incentive structures, delays reforms, imposes overly restrictive regulatory structures and imposes heavy implicit taxes on businesses. Finally, it can exacerbate social inequality that can bring economic progress to a sudden halt through violent or peaceful mass movements.

A number of studies suggest that eliminating corruption is a precondition for economic development. What if it is the other way round? What if economic progress purges corruption! There are a number of studies that point in this direction, too. Essentially, we know that economic development is negatively correlated with perceived corruption, but are we certain which way the causality runs?[i]

One of the overriding processes by which economic development can reduce corruption is by creating clear property rights and enabling mechanisms for contract enforcement. Secured property rights are definitely beneficial for economic development, as borne out by the rise of Western Europe/ England.[ii] However, as economies progress, they get better at enforcing property rights.[iii] When people/businesses have clear property rights, they have increased mobility. That’s just one way clear property rights can help reduce corruption—firms are freer to relocate more easily from a region where corruption and associated rent-seeking activities are high to another with fewer corruption issues.[iv]

Rising affluence and increased awareness among citizens also create the will to fight against state’s efforts to confiscate private property and generate rents for public servants. Crony capitalism is not really a good idea for businessmen in the long term, as gains, if any, to private business are limited to very short term. Over time, all agents (businesses and households and their groups) in the economy may begin to agree that a coercive and confiscatory state does not benefit anyone and so “vote out” any government that is overly abusive of property rights.

There are many variables other than economic development, also closely correlated with the perception of corruption. The time taken to set up a business and unexpected inflation are positively associated with the perception of corruption. Religion (especially, Protestantism), democracy, freedom of press and participation of women in government are all negatively associated with corruption. The participation of women in the workforce is, in fact, highly correlated with economic development.

While all variables point to steps that can be taken to eliminate corruption, economic development has a clear association to the perception of corruption. It’s more like an antibiotic relationship—increased corruption affects economic development adversely, while increased economic development can reduce corruption. By influencing factors that stimulate economic development, such as controlling inflation, reducing fiscal deficit, better enumeration and enforcement of land rights and investing in human capital, a virtuous cycle can be kickstarted—increasing economic development can help lower corruption that, in turn, could attract more investment and fuel economic development, which in turn could bring corruption down further until some kind of equilibrium is reached. This cycle can be helped along further by influencing factors that could reduce corruption—strengthening the democratic process, ensuring freedom of speech, easier processes for setting up and exiting business or even greater participation of women in politics.

Quite a few ideas are being debated in India and some bills along these lines have either been passed or are being considered by the Indian parliament. Examples include the land acquisition bill and women’s reservation bill, while there is growing clamour for controlling inflation and fiscal deficit. Even if the direct purpose of these bills and debates may differ from the goal of eliminating corruption, it could be a fallout. India seems to be moving in the right direction.

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[i] For an interesting review see Daniel Treisman, “What have we Learned about the Causes of Corruption from Ten Years of Crossnational Empirical Research”, November 2006 < http://www.sscnet.ucla.edu/polisci/faculty/treisman/Papers/what_have_we_learned.pdf>.

[ii] D. North and B. Weingast , “Constitutions and Commitment: The Evolution of Institutional Governing Public Choice in Seventeenth-Century England,” The Journal of Economic History, 49(4), 1989, pp. 803-832.

[iii] One simple reason for this may be growing revenues and, therefore, ability of the state to incur costs associated with enforcing property rights. Mark Gradstein, “Governance and Growth”, Journal of Development Economics, 73, 2004, pp. 505-518.

[iv] Jie Bai, Seema Jayachandran, Edmund J. Malesky, and Benjamin A. Olken, “Does Economic Growth Reduce Corruption?: Theory and Evidence from Vietnam”, April 11, 2013 < http://economics.mit.edu/files/8777>.

The Myths that the "India against Corruption" Campaign has Shattered

The varied responses from the stakeholders of the anti-corruption movement, or the Jan Lokpal Bill agitation, are interesting; they reveal the many myths that keep the discourse between those who represent and/or support the "system" and those who are on the streets protesting with Anna Hazare on different levels. Three leading myths I've  deconstructed below:

Myth #1: The agitators are holding the system to ransom, and that cannot be allowed. The movement, and the spontaneous flow of people on to the streets, is precisely this: hold the system to ransom to reform it. The view of the vast majority of people in India is that the "system" is not functioning. Indian media has regularly exposed the inefficiency, waste and corruption in the system. Indians are aware of the relatively better access to public services across the globe and are not ready to accept a sub-optimal functioning of the system. By pouring on to the streets, citizens of this country are suggesting that they are no longer content letting the system alone, to be run by politicians and bureaucrats (including all levels of government and across various departments) according to their whims and fancies. They will hold the system to ransom, if it does not deliver what they want. To ignore or attempt to squash this cry would be to risk moving into an Arab-world like crisis.

Myth #2: Only elected representatives have the right to executive and legislative functioning. The legislative and executive powers of the elected representatives flow from the people. If the citizens think that their representatives are not likely to pick up the "right" issues, they will act to force their hand. This is partly based on the political situation in India. If people vote a certain government into power, it does not mean that they are ready to accept everything that political party represents. Nor are they likely to neglect the acts of omission and commission. Citizens, after all, did not vote in favour of scams and inflation. The frustration also runs deep because electing the opposition into power may, or rather will, not change the system. So people will vote a party into power that is aligned, as much as possible, with their thinking; but they will also force them to take up issues that are critical to improving the performance of the system.

Myth #3: Anna's act has been merely theatrical. Anna Hazare's courting arrest turned out to be a strategic masterstroke, similar to Gandhiji's Dandi march. The government was shown to be using excessive force in quelling a peaceful movement. Having arrested Anna, if they release him unconditionally, they will be seen to have lost ground or bowed down to pressure. The government has got itself into a bind, and it appears very difficult to untangle the knot. However, this could also be an extraordinary opportunity for the ruling party to do itself a great favour. One parallel comes from the corporate world. Before Toyota, for the first time, recalled its cars due to a manufacturing defect, it was considered a suicidal move in the automobile industry. No one had tried it, and no one dared try it. Toyota, however, managed to build trust and close relationship with its customers by openly admitting its mistake and rectifying it. Can our politicians move out of a "feudal" mindset and agree to be led by the people?

The point is not to demonise the system. Clearly, if the country is growing at 8% or more, we have got some parts of the system right. We do have some honest and efficient politicians and bureaucrats in this country. However, having witnessed the benefits of 8% growth for a decade, the current generation wants more. They want India to be comparable to the best in the world. There is no reason why we cannot achieve it, except if we are held to ransom by an archaic, inefficient, and corrupt system that does not respond to current needs.